USA Produce More Than Saudi Arabia?

The news headlines seem to be filled with predictions for crude prices for 2013. Some are reasonably thought out while others are just plain crazy. Almost daily we hear a repeat of the USA producing more than Saudi Arabia prediction.

I have heard predictions from $65 a barrel to $115 per barrel by the end of 2013. Most are predicated on the expanding production from the Bakken and Permian Basin with Eagle Ford and others included as an afterthought. Those shale plays would have to double production more than twice to come anywhere close to Saudi Arabia.

What you don't get from the headlines is that the IEA was including "all liquids" in their projection for the USA to exceed Saudi Arabia. That means ethanol, bio diesel, coal to liquids, gas to liquids, etc. They did not say the USA was going to be producing 10.5 mbpd of crude oil any time soon.

Saudi Arabia has been producing just over 10 mbpd for the last couple of years as the Libya production was lost and the sanctions began to bite on Iran. Saudi claims they can produce 12.5 mbpd for an extended period of time although they have never produced at that level.

The U.S. produces 6.71 mbpd of crude oil. We import 7.8 mbpd.

The Bakken, Three Forks, Sanish formations are all different layers in the same geographic formation, which is actually called the Williston Basin. For simplicity sake most writers simply refer to it as the Bakken.

Williston Basin

The production from the Bakken hit a record of 662,000 bpd in September. Analysts believe that production could rise to 900,000 bpd or possibly as high as 1.1 mbpd by 2015 and remain at those levels until depletion catches up around 2020. Numerous studies of existing wells have found the depletion rate to be very high as in 65% to 75% over the first 24 months. Some wells have come in as high as 3,000 bpd but then decline to several hundred bpd over the first 12 months.

Wells are being drilled at a frantic pace but unfortunately the best acreage in the core of the play has already been developed. As exploration moves away from the core the initial production declines sharply to levels under 1,000 bpd and after 6-12 months the average well may only be producing 100 bpd.

A typical Bakken well produces 904 bpd in year one, 427 bpd in year two, 149 bpd in year three and only 82 bpd by year five. Clearly that kind of depletion curve suggests that once drilling ends the pace of production will immediately decline sharply.

However, the current pace of 2,000 new wells a year should continue through the end of the decade. However, that would require 225 active rigs and the number of rigs has fallen to 180 today. The problem is the shrinking core acreage, the decline in initial production rates as you move away from the core and the rising cost of drilling the wells. Costs are going up and revenue per well is coming down. In order to maintain the current pace of drilling the price of oil needs to remain in the $85-$90 dollar range. A decline below that level will make the noncore wells unprofitable to drill and the entire process will grind to a halt.

A Bakken well costs between $9 and $12 million to complete. The average well drilled in 2012 will produce about 615,000 barrels of oil over 45 years according to State of North Dakota estimates. That equates to $46 million in revenue at Bakken prices of $75 per barrel. However, each well will pay $4 million in taxes, $7.3 million in royalties, $2.3 million in operating expenses and salaries of $2 million. Subtract those costs and $10.5 million in drilling expenses and you still have about $20 million in profits over the 20 years the state expects the wells to produce. The key here is the core production rates. The most prolific core areas were the first to be drilled and they produced the statistics. As you move away from the core and those lifetime production numbers begin to decline to 300,000 to 400,000 barrels or even less then the math does not add up.

Also, given the rapid decline rates the majority of the money is generated in the first three years. If the well does not turn a profit in the first three years then it will be a loser for the rest of its operating life. That is not the kind of annuity these developers want.

Under the state plan the current number of producing wells will rise from 4,000 to more than 40,000 when the Bakken is fully developed. However, that would require the price of WTI oil to be well over $90 to justify continued drilling farther away from the core.

I believe the key factoid here is the decline in the number of active rigs. Developers are catching on to the lower production outside the core and many of the recently drilled wells will never be profitable. That is the kiss of death for future exploration in the Bakken. Those with core acreage left will continue to drill but those outside the core are reconsidering their options.

I suspect the optimistic projections by ND officials of a further increase of 200-500,000 bpd over the next three years before tapering off are going to be subject to negative revisions.

These problems exist in the same form only with different statistics in the other shale plays. Some areas have shallower deposits so the wells are cheaper but the ultimate production per well is lower. There is no golden goose. Each shale play is similar and each has a high decline rate. In the end it is the high rate of decline that will prevent the shale plays from reaching production rates that allow the USA to surpass Saudi Arabia in oil production.

The Eagle Ford Shale in South Texas has seen 4,397 permits issued with 1,690 wells drilled for oil and 710 for gas. The Eagle Ford core is rich in liquids including oil and NGLs but the noncore areas are gas rich with very little liquids. The play produces from depths ranging from 4,000 to 14,000 feet. In the graphic below the green dots are liquids and red dots gas. There were 270 active rigs as of Nov 16th.

Eagle Ford Shale

The Permian Basin is in West Texas and is part of the Mid-Continent Oil Producing Area. Production for that area through 1995 was more than 15 billion barrels. Some analysts believe the Permian could still contain more than 30 billion barrels of oil. Getting it out is the problem. There are already more than 155,000 wells and production is about 1.0 mbpd. If you do the math on those numbers you will find that the average well produces about 6.5 barrels per day.

New wells using horizontal drilling produce more but the Permian has never been a field of fast producers. This is an area where enhanced production is used to coax oil out of the ground. There were wells produced with water floods where water is injected into the field some distance away in an attempt to push oil towards the producing wells. They are doing the same thing with CO2 injection.

The Permian does have the possibility to increase production significantly and could possibly double production by 2020. These are cheap wells and very few dry holes but slow producers. It will take thousands of new wells to get that boost in production.

Permian Basin

I personally doubt the U.S. will ever produce more than 10.0 mbpd in crude oil to surpass Saudi Arabia. However, the oil reserves are there if the prices remain high enough to justify spending millions of dollars per well and then waiting for a 20 year payout.

It all boils down to return on investment. If oil prices were to decline to $65 as some people are predicting the production in the U.S. would fall off a cliff. New drilling would come to a screeching halt and the industry would crater like it did in the late 1990s.

I do believe oil prices will remain high because the world economy runs on oil. Once China and Europe see their growth begin to accelerate the demand for oil will also rise again and outpace the growth in production. This will keep prices high and keep the metrics positive for shale drilling in the USA.

If Europe and China don't recover soon then we could see prices decline when Iran's oil comes back online. Eventually that nuclear problem will be resolved one way or another. Iraq production is also booming but major companies like Exxon are already pulling out because of local politics and security issues. This will slow the recovery.

Petrobras will eventually get a lot of production out of their offshore finds. They are shooting for 2.0 mbpd by 2020.

All of this sounds like a lot of oil coming online that will swamp demand. However, even with the slow global economy today the demand for oil continues to expand by more than a million barrels per day, per year. When the global economy recovers that will increase to 1.5-2.0 mbpd growth per year. We don't have that much new oil production.

If growth remains at the current 1.0 mbpd per year then we will need 8.0 mbpd of new production by 2020. We will also need to replace the 4.5 mbpd we lose each year due to depletion. That means in order to avoid an oil shortage we need to find and produce 5.5 mbpd every year just to remain even.

There is a reason why Brent crude prices are still over $110. That reason is rising global demand even at the currently slower pace and the global tensions in places like Egypt, Nigeria, Libya, Iran, etc.

Will the U.S. exceed Saudi Arabia in crude oil production? Never say never but at the current price of crude I doubt it. Once WTI prices move over $100 to stay we will see a lot more drilling to offset that rapid decline in existing production.

The Egyptian stock market declined -10% on Sunday, their first business day of the week. This is in response to the Morsi decree that his government is above the law. This weekend two military buildings were blown up by militants. Protestors have called for nationwide strikes and demonstrations on Tuesday. Also on Tuesday the opposing sides have called for massive demonstrations less than a mile apart so there is a very strong possibility of violence. The problems in Egypt should continue to support crude prices.

The energy sector earnings fell -28% in Q3 as a result of lower crude prices. The odds are good that these beaten up energy stocks will see buyers before year end and into next year. I still expect some market reactions from the fiscal cliff headlines over the next several weeks so hopefully we will be able to buy some more stocks at cheaper levels.

As part of the yearend tax preparation process I would expect crude imports to begin to decline in the coming weeks. That will support prices since falling imports means lower inventories.